Death Tax: How It Works, Strategies, and Examples

Death taxes refer to the taxation of a deceased individual’s estate or inheritance. There are two main types of death taxes: **estate taxes** and **inheritance taxes**. Estate taxes are calculated based on the value of the deceased’s total assets and are paid by the estate itself before distribution to beneficiaries. Inheritance taxes, on the other hand, are imposed on individuals who inherit property from the deceased. While the federal government only imposes estate taxes, some states levy both estate and inheritance taxes.

As of 2023, the federal estate tax only applies to estates worth more than $12.92 million. This threshold increases to $13.61 million in 2024 due to inflation adjustments. Any value above this exemption is subject to federal estate tax, with rates ranging from 18% to 40%. For instance, if someone passes away in 2023 with a $15 million estate, only the portion exceeding $12.92 million would be taxed—resulting in a tax bill on $2.08 million. These thresholds are relatively high, meaning only a small percentage of Americans need to worry about federal estate taxes.

While the federal government’s estate tax has high exemption thresholds, several states impose their own estate and inheritance taxes with lower thresholds. In 2023, 12 states and Washington D.C. have estate taxes, and six states impose inheritance taxes. Estate taxes apply to the entire estate, while inheritance taxes apply to the individual recipients. State tax thresholds and rates vary significantly, so if you reside in one of these states or hold assets there, it’s critical to understand your local rules.

States with estate taxes include Connecticut, Hawaii, Illinois, and New York. For inheritance taxes, Iowa, Maryland, and Pennsylvania are among the states with such levies. Surviving spouses are generally exempt from both estate and inheritance taxes, but children and other heirs may face tax burdens depending on the size of the estate.

Both estate and inheritance taxes fall under the category of death taxes, but they differ in how they are applied. Let’s break down the distinction:

Estate taxes are calculated on the total value of the deceased’s assets, which may include real estate, investments, cash, and personal property. The estate is responsible for paying the tax before the remaining assets are distributed to beneficiaries. These taxes are progressive, meaning that the higher the estate’s value, the higher the tax rate. Federal estate tax rates range from 18% to 40%, depending on the estate’s size. Only estates exceeding the exemption threshold ($12.92 million in 2023) are subject to estate taxes.

Inheritance taxes differ from estate taxes because the tax burden falls on the beneficiaries, not the estate. The tax rate depends on the relationship between the deceased and the beneficiary, as well as the value of the inheritance. Close relatives such as spouses and children often benefit from lower tax rates or full exemptions, while distant relatives or unrelated individuals may face higher rates. Inheritance taxes are only imposed by a few states, such as Iowa, Kentucky, and New Jersey.

If you expect your estate to exceed the federal or state tax exemption limits, proactive estate planning can help minimize or avoid death taxes. Here are several strategies to consider:

Placing your assets in an irrevocable trust can shield them from estate taxes. Once assets are transferred to the trust, you relinquish ownership and control, meaning they are no longer part of your taxable estate. The trust can then distribute income or assets to beneficiaries according to your wishes. One popular option is a **grantor retained annuity trust (GRAT)**, which allows you to receive annuity payments for a set period, after which the remaining assets are passed to beneficiaries with minimal tax implications.

Another effective way to reduce your taxable estate is by making gifts to your family and friends during your lifetime. The IRS allows individuals to give up to $17,000 per year (as of 2023) to each recipient without triggering gift taxes. Additionally, you can take advantage of the **lifetime exclusion limit**, which matches the federal estate tax exemption ($12.92 million in 2023). By gifting assets during your lifetime, you can lower the value of your estate and reduce potential tax liability.

The unlimited marital deduction allows you to transfer an unlimited amount of assets to your spouse, either during your lifetime or at death, without incurring federal estate or gift taxes. This provision effectively treats a married couple as a single economic unit, deferring any estate taxes until the death of the surviving spouse. However, when the second spouse passes away, the combined value of both estates may exceed the exemption threshold, triggering estate taxes unless further planning steps are taken.

Charitable donations provide another way to reduce your estate’s taxable value. By making donations to qualified charitable organizations, you can deduct the donation amount from your estate. This not only supports causes you care about but also reduces the tax burden on your heirs. Many individuals establish **charitable remainder trusts (CRTs)** to leave a portion of their estate to charity while providing income for beneficiaries during their lifetimes.

Death taxes, including both estate and inheritance taxes, primarily affect wealthy individuals with estates that exceed federal and state exemption thresholds. While most people won’t need to worry about paying these taxes, it’s important for those with substantial assets to understand how death taxes work and the strategies available to reduce or avoid them. By using tools like irrevocable trusts, lifetime gifts, and the unlimited marital deduction, you can significantly lower the tax burden on your estate. Proactive estate planning ensures that more of your hard-earned wealth goes to your loved ones, rather than being consumed by taxes.

Death taxes refer to estate taxes and inheritance taxes levied on the transfer of assets after a person dies. The federal government imposes estate taxes on estates valued above a certain threshold, while some states levy both estate and inheritance taxes. Estate taxes are paid by the estate before assets are distributed, whereas inheritance taxes are paid by beneficiaries receiving the inheritance.

Estate taxes are imposed on the entire value of the deceased person’s estate before assets are distributed to heirs. In contrast, inheritance taxes are paid by the individuals who inherit the assets, and the rate of taxation can vary based on the beneficiary’s relationship to the deceased. Close family members may pay less or no inheritance tax, while distant relatives or unrelated individuals may face higher taxes.

The federal estate tax only applies to estates that exceed $12.92 million in 2023 (rising to $13.61 million in 2024). In most states, transfers to a surviving spouse are exempt from both estate and inheritance taxes. In some states, close relatives like children and grandchildren may also qualify for exemptions or reduced rates on inheritance taxes. Certain charitable donations and gifts made during the individual’s lifetime may also be exempt from death taxes.

Lifetime gifts allow individuals to reduce the size of their taxable estate by giving assets away to family and friends before death. In 2023, you can give up to $17,000 per year to each person without triggering gift taxes. Additionally, you can use the lifetime exclusion limit, which is the same as the estate tax exemption amount ($12.92 million in 2023). By giving away assets during your lifetime, you lower the value of your estate and reduce the potential tax burden on your heirs.

Under the unlimited marital deduction, you can transfer an unlimited amount of assets to your spouse, either during your lifetime or at death, without incurring estate or gift taxes. This provision treats married couples as a single economic unit, deferring estate taxes until the death of the surviving spouse. However, when the second spouse passes away, their combined estate may be subject to estate taxes if it exceeds the exemption threshold at that time.

The current estate tax thresholds are set by the Tax Cuts and Jobs Act (TCJA), which is set to expire after 2025. If Congress does not extend the provisions, the federal estate tax exemption may revert to pre-TCJA levels, which were significantly lower. This means that more estates could be subject to estate taxes starting in 2026 unless new legislation is passed to maintain or increase the current thresholds.